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More Tips and Tools for Getting Started Right 235

• Diversification can dilute your results. Your goal is to have your
biggest winners also be your biggest positions. If you get a 100% gain in a
stock that is only 1 of 20 different positions in your portfolio, it’s a nice
percentage gain—but it doesn’t make you any significant money.
• Over-diversification can lead to buying some stocks with less
potential or lower quality. Will you really achieve superior results by
buying inferior stocks? Be picky, and only invest in top-rated stocks that
pass the Buying Checklist.
• Over-diversification does not protect your portfolio. Here’s why the
idea of “safety in numbers” doesn’t apply to your portfolio.
First, it’s much harder to spot early warning signs if you have to con-
stantly track 15 or 20 stocks. But you can do it very quickly if you only
need to check in on 3 or 4 positions.
Second, when you own a lot of stocks, you also have to sell a lot of
stocks to protect your overall portfolio. If you own 20 stocks, will you
really sell 10 or 15 of them quickly enough to avoid serious damage?
Remember: A market downtrend will take 3 out of 4 stocks down with
it. Owning a bunch of stocks doesn’t change that fact—it just makes it
that much harder to reduce your risk.
On the other hand, if you own 3 or 4 stocks, you only need to sell 1 or
2 to quickly safeguard a significant portion of your money.

So What Are the Right Reasons to Diversify?
The main one is to avoid putting all your money into one industry.
For example, if you own nothing but semiconductor stocks or nothing but
housing stocks—both of which are cyclical industries—you’re taking on
undue risk. If bad news or an economic downturn suddenly rocked the
industry, all of your stocks might instantly sell off.
Stocks move in groups. If institutional investors start pumping money into
a particular industry, stocks in that business will generally go up. And when
fund managers decide they want out, all stocks in that group are at risk.
In Bill’s quote at the beginning of this chapter, he didn’t say put all your
eggs in one basket. The point is that you don’t want to diversify just because
people say diversification is “good” or “safe.” Instead, concentrate on a few
stocks in a “few” baskets—and watch them very carefully.